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(Updates with deputy governor’s comments in eighth paragraph.)
Oct. 26 (Bloomberg) -- Turkey’s central bank more than doubled borrowing costs for banks, effectively raising interest rates to tackle the threat of inflation. Bond yields and the lira surged.
The central bank today denied banks access to funding at the benchmark one-week repo rate of 5.75 percent and instead provided it only through the overnight lending rate, at a cost of as much as 12.5 percent, governor Erdem Basci told reporters in Ankara. The central bank will retain the power to shift rates between those levels, he said.
Basci is marshaling dwindling foreign-currency reserves to rebuild confidence in the lira. The currency slumped 17 percent against the dollar in the first nine months of the year, fueling inflation. Turkey is one of many emerging markets struggling to manage shifting capital flows as European leaders debate a solution to their sovereign debt crisis, Basci said, adding that the new measures will stay in place as long as it takes to restore confidence in the currency.
“Extraordinary times require extraordinary measures and the central bank is doing that,” Tevfik Aksoy, chief economist for the region at Morgan Stanley & Co. in London, said by e- mail. Basci is “aiming to achieve stability in the currency, slow credit expansion, tighten monetary policy outright and take measures to allay concerns regarding foreign-currency reserve sufficiency.”
The lira rose 1.2 percent to 1.7585 per dollar at 4:30 p.m., extending its gain this month to 5.8 percent. The currency is “slightly undervalued,” Basci said today. Yields on two- year bonds rose 33 basis points to 9.95 percent, heading for the highest close since August 2009.
The central bank acted after predicting a “sharp” increase in inflation and saying economic activity and bank lending are proving stronger than it had forecast.
The new policy will mean “higher effective interest rates,” deputy governor Turalay Kenc said in an interview in London. “Through liquidity provision we will try to influence the market interest rate. We think it’s going to be more effective rather than changing our policy rate.”
The overnight repo rate between banks increased to 11.1 percent from an average of 10.9 percent yesterday, data from the Istanbul Stock Exchange showed.
The bank “will determine interest rates on a daily basis,” Inan Demir, chief economist for Finansbank AS in Istanbul, said by e-mail. “The bank thinks current circumstances require a higher interest rate, and interbank rates will be allowed to settle close to the 12.5 percent ceiling for some time.”
The index of Turkish banking shares fell 1.5 percent, extending its decline to 7.1 percent since Oct. 20, when the central bank first indicated it would move toward a tighter policy. Losses were led by Akbank TAS, a bank partly owned by Citigroup Inc., which dropped 2.7 percent to 6.44 liras.
The central bank raised its forecast for inflation this year to 8.3 percent from the 6.9 percent it predicted three months ago. Inflation was 6.2 percent in September. The prediction is based on an assumption of a “significant monetary tightening in the last quarter of the year,” Basci said today.
The bank’s inflation goal for this year is 5.5 percent and it “won’t tolerate” any long-term deviation from that target or allow the higher current rate to set expectations, Basci said. The new forecast also exceeds the 8.01 percent predicted by economists and executives in the central bank’s last two-week survey on Oct. 20.
Inflation has accelerated because of the weaker lira, which drives up import costs, combined with stronger-than-forecast domestic growth and tax increases on items including tobacco and mobile phones that were “much higher” than the central bank expected, Basci said.
Credit growth is also too rapid and should slow, he said. Bank loans increased 38 percent from a year ago, according to Oct. 24 figures from the industry regulator.
Still, the focus for policy makers in Ankara is how European governments handle their sovereign debt problems, Basci said. The bank is prepared to take steps to lower reserve requirements for lira liabilities and increase the proportion of reserves that banks can hold in foreign currency to 40 percent from 20 percent, he said.
The bank has sold about $8.5 billion since August to support the lira, and is ready to spend more, Basci said. Reserves stood at $85.9 billion on Oct. 14, equivalent to more than four months of imports.
--With assistance from Mark Bentley in Istanbul and Agnes Lovasz in London. Editors: Heather Langan, Ben Holland.
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